30067 Economic History (2014-2015)

Andrijana Radojicic
ID: 1798412

Take-home essay

A comparison between the first financial

crisis in 1720 (following the South Sea
Bubble and

Mississippi Bubble) and the stock market

crash of 1929.
Andrijana Radojicic
[1798412@studbocconi.it]
Word count: [1331]
Apart from the primary function of harmonizing the discrepancy between
unlimited demand and limited supply, the economy has evolved into an ever
changing system interwoven of historical, cultural, political, moral,
technological and legal aspect of a country. As many occurrences in the
world history have proven, the society's dependence on economy is
juxtaposed with the influence it has over it. Evidence can be found whilst
examining financial crises of 1720 and that of 1929.
In the early 18th century, the British empire was facing a financial fall after
a speculative bubble, which is known as the South Sea Bubble, had burst. It
all started with the establishment of the South Sea Company (SCC) in 1711
which was granted a monopoly in trade with South America and the West
Indies-Spanish colonies at the time. This sparked the initial interest of the
public, as this was seen as an opportunity to exploit gold and silver mines of
Peru and Mexico. In exchange, the company took upon the national debt
raised by the War of Spanish Succession and the responsibility to

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30067 Economic History (2014-2015)

Andrijana Radojicic
ID: 1798412

consolidate it by converting successive portions of debt into shares. 1

Unfortunately, the company was left with the limited trade opportunities,
that is the right of supplying Spanish colonies with slaves for 30 years and
sending ships once a year to South America, as Spain confirmed sovereignty
over its colonies. The trading operations were not efficient nor profitable, yet
in 1719 the Parliament authorized the company to assume an additional
portion of the national debt.2 The public was confident in the South Sea
Company and the value of its stocks. Nobody questioned the repeated reissues of stocks so future expectations were constantly rising, along with the
stock prices. The chart below depicts the extreme movement of stock prices. 3

The constant increase in stock prices was driven up by several reasons.

Firstly, a couple of acts were passed by the government which benefited the
South Sea Company, Bubble Act being the most important. It granted the

1 Mackay,1852.
2 Harvard Business School Library, 2010.
3 Garber, 1990.
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30067 Economic History (2014-2015)

Andrijana Radojicic
ID: 1798412

company with its royal charter, which was perceived as governments act of
confidence with it. Furthermore, this allowed the SSC to control the
competition and gain even greater share of the aggregate demand for
investment. 4 Secondly, the company carried out four cash subscriptions with
very generous terms which enabled even the poor to invest. 5 Lastly, the
speculations, misinformation and manipulated press influenced greatly the
inexperienced investors. The higher the prices, the greater the demand for
stocks was. Despite all this, the SSC was way over-valued given that it
performed very poorly, and was unable to break even, let alone meet the
expectations. Many investors caught on and started selling their stocks.
Consequently, in September 1720, the bubble burst, stock market crashed
and stockholders faced catastrophic losses.6
During the same period, another financial bubble assumed a similar form in
France, called the Mississippi bubble. In the early 18th century, France was
essentially insolvent as a country. The government decided to assign John
Law, a British exile, the task of overcoming these financial struggles. He
introduced the national Banque Gnrale to the system and thus made the
transition from metallic to paper currency. Furthermore, in August 1717,
Law acquired the a trading company, the Mississippi Company. He was
granted the monopoly on trade in French North American colonies.7 Two
years later, the company subsumed the entire national debt, offering the
possibility to exchange portions of it for stocks in the company. Similarly to
the situation in Britain, the public was beyond enthusiastic and the demand
for investment was tremendous, as high expectations were set. In response,
the national bank printed as much money as the nation required.

4
5
6
7

Harris, 1994.
Mackay,1852.
Beattie, 2015.
Garber, 1990.
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30067 Economic History (2014-2015)

Andrijana Radojicic
ID: 1798412

Consequently, this gave rise to powerful inflation during which the prices of
the stocks soared.8

In May 1720, the bubble burst, as the government acknowledged that the
amount of gold in the country was nowhere near the amount of total paper
currency in circulation. The decision was made to gradually depreciate the
value of stocks. Panicked investors induced aggressive selling, causing the
stock price to drop sharply. Many were financially ruined, Law fled the
country, and the Banque collapsed. The France was ushered in an economic
depression.
Despite all the similarities between the South Sea and Mississippi Bubble,
there is a crucial distinction- the financial crisis in Britain occurred
primarily due to widespread mania and speculation, while France in
addition implemented inadequate monetary policies.

8 Colombo, 2012.
9 Thornton, 2010.
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30067 Economic History (2014-2015)

Andrijana Radojicic
ID: 1798412

Fast forwarding to the early 20th century in the United States, another
infamous financial crisis arises. The 1920s were the golden age of America.
The nation was in prosperity, living standard was high, and many inventions
were conceived. The lavish lives of the population were credibly described in
Fitzgeralds work, and as the contemporary president Calvin Coolidge stated
at his 1928 State of the Union address, the America had never met with a
more pleasing prospect than that which appears at the present time.10
Given that many were well-situated, encouraged by the economys strength,
the demand for the investment rose, and the stock market flourished.
Moreover, people were taking out loans and buying on the margin in order to
invest. The market peaked in September 1929, and the Dow Jones Industrial
Average stood up 27% from the previous year.11

10 Suddath, 2008.
11 Suddath, 2008.
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30067 Economic History (2014-2015)

Andrijana Radojicic
ID: 1798412

Once again in the economic history, many inexperienced investors were

present in the stock exchange, which allowed the manipulation and creation
of the speculative bubble. Stocks kept rising and people continued to buy
them. The problem occurred when the prices became detached from the
potential earnings, as they were not driven up by economic fundamentals
but by the exuberance of the investors. In October 1929, some companies
reported disappointing results. Many investors pulled out from the market,
and once again in the history, the selling mania began. In spite of many
attempts by the financiers, such as JP Morgan, to restore confidence and
raise the prices by purchasing stocks, the prices declined steadily.12 The
consequences were devastating. In 1932, the GDP fell by a third,13 and by
1933, the majority of the banking system ceased to function14, as the banks
were unable to collect on loans made to stock market investors. Companies
incurred huge lay-offs, wages declined, and the nation was woken up from
their American Dream by the reality of the Great Depression.
All three events discussed in this paper resulted in severe financial crisis.
Britain managed to offload its debt, by committing the bank to managing the
national finances and the Parliament to enacting adequate regulations.
Upon the burst of the bubble in France, the government was left basically
debt-free, however the groundwork was set for the French Revolution.
Lastly, the United States transitioned from the Roaring Twenties to the
Great Depression which lasted until the World War II.
One may distinguish a pivotal similarity between these historical episodes
reflected in the presence of manipulation of inexperienced investors.
Behavioral finance often refers to Keynes who highlighted the influence of

12 Wattenberg, N/A.
13 James, 2010.
14 Wattenberg, N/A.
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30067 Economic History (2014-2015)

Andrijana Radojicic
ID: 1798412

psychology in finance. He stated that sentiment, unrealistic optimism or

pessimism affect economic booms and subsequent busts.15 Aspiring for
wealth and status blinds individuals and bring up the concept of herd
mentality. The mass madly follows the leader and plays the game without
knowing the rules. Greedy individuals take upon this opportunity and enjoy
the ride on the bubble. However, as easy it is to build investor confidence and
generate frenzy, the followers get easily spooked and panicked. This is what
happened with each of the distinct cases considered in this essay. As the
fictional character, Harvey Spector, in the television show Suits says: I
dont play the odds, I play the man.

.
References
1. Andrew Beattie, The Greatest Market Crashes. [Investopedia 2015]
<http://www.investopedia.com/features/crashes/>
2. Ben Wattenberg, The First Measured Century, [Public Broadcasting
Service] http://www.pbs.org/fmc/timeline/estockmktcrash.htm
3. Charles Mackay, Memoirs of Extraordinary Popular Delusions and
the Madness of Crowds. [Library of Economics and Liberty 1852]
<http://www.econlib.org/library/Mackay/macEx2.html>.
4. Claire Suddath, BRIEF HISTORY OF The Crash of 1929, [TIME
2008] <cotent.time.com/time/nation/article/0,8599,1854569,00.html>
5. Harold James, Representations, Vol. 110, No. 1, [University of
California Press 2010]

15 Shefrin and Statman, 2011.

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30067 Economic History (2014-2015)

Andrijana Radojicic
ID: 1798412

6. Harvard Business School Library, accessed 28 April 2015, <

http://www.library.hbs.edu/hc/ssb/history.html>
7. Henry Thornton, The Mississipi Bubble, [Henry Thornton 2010]
http://www.henrythornton.com/blog.asp?blog_id=1741
8. Hersh Shefrin, Meir Statman, Behavioral Finance in the Financial
Crisis: Market Efficiency, Minsky, and Keynes, [Santa Clara
University 2011]
9. Jesse Colombo, The Bubble Bubble, [The Bubble Bubble 2012]
http://www.thebubblebubble.com/historic-crashes/
10. Peter M. Garber, The Journal of Economic Perspectives, Vol.4, No.2.
[American Economic Assosciation 1990]
11. Ron Harris, The Journal of Economic History, Vol. 54, No. 3.
[American Economic Assosciation 1994]

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